Euro ‘Funding-Currency’ Status at Risk on Hawkish Fed Outlook

Fundamental Forecast for Euro:Neutral

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The Federal Reserve’s September 17 interest rate decision may heavily impact the near to medium-term outlook for EUR/USD especially as the European Central Bank (ECB) shows a greater willingness to further embark on its easing cycle.

EUR/USD remained bid ahead of the Fed’s policy meeting as market participants continue to treat the Euro as a funding-currency, but the fresh rhetoric coming out of the Federal Open Market Committee (FOMC) may bring the broader fundamentals back in play amid the deviation in the policy outlook. Despite waning expectations for a September liftoff, the Fed may stay on course to lift the benchmark interest rate in 2015 as central bank officials still anticipate a stronger recovery to emerge over the remainder of the year.

As a result, the fresh updates coming out of the FOMC may heighten the appeal of the greenback and undermine the recent advance in EUR/USD should Chair Janet Yellen make an increased effort to prepare U.S. households and businesses for higher borrowing-costs. In contrast, another unanimous vote to retain the current policy paired with more of the same language from the July 29 rate decision may highlight the risk for a further delay of the normalization cycle as the central bank pays increased attention to the downside risks surrounding the global economy.

In contrast, the recent commentary coming out of the ECB suggests that the Governing Council stands ready and willing to implement additional monetary support as weak energy prices accompanied by the resilience in the single currency dampens the outlook for inflation. In turn, the ECB may have little choice but to increase the duration/scope of its quantitative easing program as the central bank struggles to achieve its one and only mandate for price stability.

With that said, the long-term bearish outlook for EUR/USD may come back into light should the Fed keep a 2015 liftoff on the table, and signs for an looming rate hike may put the exchange rate under pressure as interest rate expectations pickup.